Dynamic Stock Markets with Multiple Assets: An Experimental Analysis

Abstract

We study the performance of the rational expectations hypothesis in multiperiod experimental markets with multiple assets. We find that the markets are generally inefficient from the point of view of full information aggregation. However, arbitrage relationships hold, and it is not possible to detect the informational inefficiency by using some standard tests of market efficiency. These findings suggest that the lack of arbitrage opportunities and the failure of common tests to reject inefficiency are not sufficient to conclude that a market is informationally efficient.A GROWING BODY OF research has investigated whether the rational expectations hypothesis provides a reasonable description of behavior observed in laboratory markets. In this paper, we continue this investigation by examining information aggregation in fairly complex multiperiod markets with multiple stocks and experienced traders. We find strong evidence against information aggregation. However, we also find that conventional econometric tests are unable to reject the hypothesis of an informationally efficient market.Our study consists of two markets, one with three stocks and one with four. In each market, each stock has a two-period life. A stock pays a dividend at the end of each period, and the underlying distribution of endowments is common knowledge. Traders are given private information about the dividends.Important features of our laboratory markets are: (a) trading takes place in continuous time in a computerized market; (b) multiple units of the same asset can be traded in a single transaction; (c) the same dividends are paid to all owners of a stock; (d) the distribution of private information is not common knowledge; and, (e) borrowing and short sales are allowed.We analyze the data obtained from the experimental sessions in several ways. First, we study how efficiently our markets aggregate information by measuring the extent to which market prices reflect all available information. Since a stock pays dividends in both periods, the aggregation problem in the first period is more difficult than in the second (since the rational expectations price must correctly forecast the sequence of dividends). We find * Graduate School of Industrial Administration, Carnegie Mellon University. We thank without implicating two anonymous referees, seminar participants at Carnegie Mellon University, Duke University, MIT, and Washington University, the editor Rene Stulz, and Stan Zin for helpful comments. 1812The Journal of Finance that the rational expectations model does not perform well in the first period, but does better in the second period. This conclusion does not seem to depend on the number of securities in the market.Second, we ask whether some standard tests of market efficiency detect the deviations from rational expectations. In applying these tests, we assume the role of an econometrician who can only observe market data, not the underlying fundamentals.1 We find that, despite the lack of informational efficiency, the econometric tests d...

A Test of the Modigliani‐Miller Invariance Theorem and Arbitrage in Experimental Asset Markets

“…7 See the surveys in Cadsby and Maynes (1998) and Sunder (1995). Srivastava (1991) replicate portfolios of options, stocks, and cash in a multipleasset experimental market with two stages and information asymmetry. The authors show that if the information asymmetry cannot be resolved, price discrepancies frequently persist.…”

How Do Market Prices and Cheap Talk Affect Coordination?

“…Prior experimental market studies mostly focus on the market's ability to aggregate information. Studies have shown that markets can disseminate private information (Plott and Sunder [1982]) and aggregate diverse private information under certain conditions (Plott and Sunder [1988], Lundholm [1991], O'Brien andSrivastava [1991]). In prior experiments, dividends are exogenously specified.…”

Long Term Dynamics of Indian ADRs Market: The Case of Persistence and Irregular Cycles

“…However, the available empirical literature provides mixed evidences on the applicability of RWH in security markets. Some studies support it (Godfrey et al, 1964;Fama, 1965;Fama, 1970;Fama, 1991;Alford & Guffey, 1996;Dow & Gorton, 1997;Barkoulas & Baum, 1997), and many others refute it (Grossman & Stiglitz, 1980;Shiller & Perron, 1985;Lo & MacKinlay, 1988;O'Brien & Srivastava, 1991;Barkoulas & Baum, 1996;Peress, 2010;Latif et al, 2011;Patel et al, 2012;Immonen, 2015). The rejection of the RWH infers existence of dependence and predictability in security returns.…”